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Are gold prices about to fly? Gold is a hedge against a policy mistake, says Pepperstone

Kitco News

(Kitco News) The recent trading pattern in gold shows signs that a bull market could be just around the corner, with investors starting to price in a possible policy mistake as central banks worldwide begin to raise rates.

Gold hit two-month highs this week as prices surged above $1,845 an ounce level. But what's surprising is the environment in which the yellow metal is able to make new gains — a hawkish central banks backdrop and rising U.S. Treasury yields.

"We are not just talking about the rise in nominal Treasury rates, we are talking about the rise in real Treasury rates. And these are Treasuries adjusted for inflation expectations. Usually, gold and yields move in a close inverse relationship. If real rates go higher, then gold goes lower," said Pepperstone head of research Chris Weston.

Gold doesn't have a yield. This is why when yields on a real basis climb, gold becomes less attractive. "Since the start of the year, we are seeing a really interesting dynamic where real rates are moving sharply higher, but gold price is holding in really well," Weston said on Thursday.

This is a major development that cannot go unnoticed. The markets are already pricing in at least four rate hikes this year as the Federal Reserve is gearing up to fight four-decade high inflation in the U.S. But the gold market seems to be getting ready for something else — a policy mistake.

"Gold is not an inflation hedge at the moment. It is a hedge against a policy mistake," Weston said. "Markets are saying we will see four or five rate hikes this year, with passive balance sheet runoff. Does that mean we are closer to a policy mistake? I think this is what you are seeing in a gold market — if central banks have to backtrack, gold will absolutely fly. It is a hedge you have in your portfolio against this policy mistake."

A surge in crude oil prices is also contributing to this argument as higher oil is helping to support gold.

"That's going to be another nail in the coffin for the consumer. And as demand ramps up, we will be talking about $100 oil. This will feed into the gold situation due to rates pricing. If central banks raise by the projected amount, do we want a 10% allocation to gold and silver? That's exactly what you're seeing in the market. That's why it has broken away from nominal and real rates, and people are saying let's have a hedge against a policy mistake."

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And as gold continues to make a series of higher lows, the next big move could come once the precious metal reaches $1,850 an ounce.

"If we were to get to $1,850 in the weeks ahead, that's when we'll start seeing a bull trend going forward," Weston noted. "If we were to see this thesis of the market saying we might have a policy mistake and we need to hedge against that, gold will continue to be in demand, and the gold market will fly. This could be where the next bull market comes through in gold."

One sign to watch for is gold rallying in every currency. "That's when you know people are looking for gold itself, and it's not just having that currency effect," Weston clarified.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.